SEBI: Franklin Templeton mutual fund case
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This article is written by Daksh Ghai, from Symbiosis Law School, Noida. The article provides a brief overview of the functions and powers of SEBI and the provisions under Section 11C of the SEBI Act.

About SEBI 

On April 12, 1988, the Securities and Exchange Board of India (SEBI) was established as a non-statutory body by an administrative resolution of the Government to deal with all aspects involved in the development and regulation of the securities market, as well as investor protection, and to make recommendations to the government on all of these issues. An ordinance promulgated on January 30, 1992, granted SEBI statutory status and powers. 

On February 21, 1992, SEBI was established as a statutory body. On April 4, 1992, the Ordinance was repealed and SEBI was accorded with statutory powers with the passing of the SEBI Act, 1992 by the Indian parliament. It was put in place to increase transparency in the Indian investment market. 

Aside from its head office in Mumbai, the organisation has regional offices throughout the nation, which include New Delhi, Ahmedabad, Kolkata, and Chennai. It is tasked with regulating the functioning of the Indian capital market. The regulatory body focuses on regulating and monitoring the Indian securities market to protect investors’ interests. It aims to instil a stable investment process by developing various laws and regulations as well as developing investment-related directives.

Why was SEBI established?

SEBI was established to keep an eye out for unfair practices and to protect investors from them. The organisation was established to meet the needs of the three groups listed below:

  1. Issuers: SEBI works to provide investors with a marketplace where they can raise funds equitably and smoothly.
  2. Intermediaries: SEBI provides a platform to the intermediaries and strives to provide intermediaries with a professional and competitive market.
  3. Investors: SEBI helps safeguard the investors and provides them with accurate information regarding the companies relevant for investment in public domains and helps the investors take informed investment decisions and makes the market transactions safe. 

Powers of SEBI

Quasi-judicial powers  

SEBI has the authority to issue judgments in cases of securities market fraud and unethical practices. If it finds someone breaking the rules, the regulatory body has the power to apply rules, pass judgments, and pursue legal action against the offender.

Quasi-executive powers 

SEBI has the authority to inspect the books of accounts and other important documents to detect or collect evidence of violations. The aforementioned authority makes it easier to maintain transparency, accountability, and fairness in the securities market. 

Quasi-legislative powers

The authoritative body has been entrusted with the power to develop appropriate rules and regulations to protect the interests of investors. Listing obligations, insider trading prohibitions, and essential disclosure requirements are common examples of such policies. The body establishes such rules and regulations to eliminate securities market wrongdoings.

SEBI Act 

The Act gave SEBI the power to regulate capital markets, not just to observe but also to enforce the guidelines and twin goals of the SEBI Act, namely, the protection of investors’ interests and the orderly evolution of capital markets. The SEBI Act regulates the following areas:

  • Members of the SEBI Board of Directors, their composition, and their actions. 
  • The Board’s Roles and Responsibilities are outlined in the Act
  • SEBI’s funding sources, which include donations from the Union Government.
  • Sanctions and legal channels are governed by these rules.  

Provisions under section 11C of the Act

Section 11C of the Act talks about investigation. Investigations are conducted to gather proof of alleged securities market violations such as price tampering, artificial market formation, insider trading, public issue related irregularities, and other misconduct, as well as to identify the individuals or entities responsible for these irregularities and violations. 

SEBI’s investigative powers are broad, and even before an inquiry is started, it can result in severe civil and criminal penalties. Over the years, SEBI has stepped up its investigating efforts.

When can the board start an investigation?

The board under Section 11C(1) can direct an individual to investigate the affairs of such intermediary or anyone affiliated with the securities market at any time by writing an order if the board has grounds to believe that securities transactions are being handled in a way that is harmful to shareholders or the securities market, or if any intermediary or person associated with the securities market has violated any of the provisions of this Act.

Duties of such intermediary or persons to comply with the authorities

Under Section 11C(2), 11C(3), all books, registers, other documents and records of, or relating to the company must be preserved and produced to the Investigating Authority, or any person authorised by it on its behalf, by every director, officer, employee of the firm, or anyone affiliated with the securities market. 

The Investigating Authority will have the right to retain the records with them for a period of six months and can call for the records again from the intermediaries mentioned under Section 12 if the Investigating Agency needs the documents again.

Impounding of documents

If the investigative authority has substantial grounds to believe that the intermediary in possession of the document can change, destroy, or hide the records from the authority. The Investigating Authority can then apply to the magistrate/court for an order impounding the documents, and the investigation authority is allowed to keep the confiscated documents with them until the investigation is completed.

Exemption

Unless a company engages in insider trading or market manipulation, a magistrate, judge, or court cannot order the seizure of books and other documents of a listed public company or a public company (other than the intermediaries listed under section 12) that intends to get its securities listed on any recognised stock exchange.

Examination on oath

Under Section 11C, a company’s management, director, employee, or intermediary can be questioned under oath by the investigation agency. The investigating agency may take notes on the examination and have the person examined sign it so that it can be used against them as evidence. It necessitates the person’s personal appearance before the investigative agency.

Punishments under the section

If a company’s management, director, employee, or intermediary fails to deliver reports, information, or documentation that he is required to be produced or fails to participate personally before an investigation agency or sign examination notes, he will have to face imprisonment for up to one year, or a fine of up to rupees one crore, or both, as well as a fine of up to five lakhs per day during which the failure continues. 

Legal representation during an investigation under the Act

While ‘Courts’ and ‘Tribunals’ have a clear ‘judicial’ character to them and hence leave little debate about the application of legal representation, regulators frequently exercise quasi-legislative, quasi-executive, and quasi-judicial authorities. As a result, the conditions surrounding the right to legal representation before regulators are complex. 

In Lafarge Umiam Mining Pvt Ltd v. Union of India (2014), the Supreme Court noted the distinction between a ‘Regulator’ and a ‘Court’ or ‘Tribunal,’ saying: “The distinction between a regulator and a court must be borne in mind.” The court/tribunal is essentially an authority that responds to a matter that has been brought to its attention. A regulator, on the other hand, is a constructive entity with the authority to enact statutory legislation and norms. 

SEBI has not developed a standard or sanctioned legal representation at the investigative level.  The SEBI rulebook or standards for conducting investigations have remained secretive and confidential. In the absence of an explicit judgement under securities regulations, administrative tribunals and statutes can be used as precedents.

In Kothari Industrial (1995), the Karnataka High Court considered whether the Chief Coffee Marketing Officer, before whom proceedings were begun, constituted a “Court, Tribunal, or Authority,” and therefore whether an individual has the power to nominate an attorney before such proceedings. The Karnataka High Court held that when a person is “legally authorised to take evidence” due to a contract rather than a statute, as was the case with the Chief Marketing Officer, the proceedings before this officer are not like those before a Court, and thus there is no right for a litigant to be represented by an Advocate.

In the case of Kothari Industrial, it was held that the right to legal representation cannot be exercised during a “preliminary” stage of an inquiry proceeding, there is a growing trend of decisions that have allowed legal representation and the presence of an advocate during such preliminary stages of proceedings with some safeguards.

In Mitesh Manubhai Sheth v. Secretary, Government of India and Others (1997), the Gujarat High Court found in favour of the broker’s right to be represented by a lawyer. The court decided that having a lawyer present is beneficial not only to the criminal but also to the tribunal or inquiry committee in reaching a just and suitable verdict. It is now generally accepted that, in a matter involving a judicial, quasi-judicial, or even administrative decision that affects a person’s legal rights, the party affected should be allowed to be defended by a lawyer if the facts of the case merit it.

Case law related to investigation under the SEBI Act 

Mahesh Kumar Patel v. Adjudicating Officer (2005) 

Facts

In this case, SEBI initiated an investigation in 2004 into the unexpected spike in the price of Sword and Shield Pharma Ltd. (SSPL), within a short span of time. On June 25, July 19, August 9, and August 23, summonses/letters were issued to Mahesh Kumar Patel, the appellant in connection with the investigation under section 11C of the SEBI statute. The appellant did not show up for his hearing with the Investigating Authority. Adjudication procedures were started in response to the claimed non-compliance with SEBI’s summons

Issue 

The appellant alleged that he did not fall “within the ambit, scope, and jurisdiction of SEBI” because he was not a registered intermediary with SEBI.

In response to SEBI’s summonses/letters, the appellant claimed that Aarushi Consultancy, of which he was the Proprietor and had received similar letters from SEBI in the same matter, and he had already submitted the information required by SEBI, and thus he did not and was not required to submit any other information.

Judgement

The appellant is a participant in the securities market, as he is the sole proprietor of Aarushi Consultancy and is also a frequent trader in the stock market, as shown by his own Demat account. So his contention that he didn’t fall under the jurisdiction was wrong and SEBI, under the section 11C (3), had the power to call an intermediary or any person associated with the securities market to provide information to the investing authority and as a person involved in the securities market, he was expected to provide all information to the Investigating Authority that was required or considered necessary for the Investigating Authority’s investigation. 

He was not able to prove that the information he was asked for was the same as what Aarushi Consultancy needed. The appellant’s primary presumption was that whatever Aarushi Consultancy had supplied would suffice for the summons he had received.

By failing to respond to the summons and failing to appear before the Investigating Authority, he denied the Investigating Authority the opportunity to obtain clarifications or additional information from him, which he would have been able to provide as the proprietor of Aarushi Consultancy and which could not have been conveyed through Aarushi Consultancy’s written submissions. 

Conclusion

SEBI’s investigations over the last few years have had a positive influence on the financial market. The investigations, together with continuous surveillance methods, have reduced the number of claimed market manipulations and price rigging cases. 

Following the conclusion of the investigation, a variety of administrative and punitive proceedings were taken under the SEBI Act and the different SEBI Rules and Regulations. Money penalties, warnings, suspension of activities and cancellation of registration, restricting dealing in equities and access to the equity market, asking trustees and key persons of mutual funds to resign for failing to protect the interests of investors, and so on are examples of these actions.

References

 


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